Orion Controls Case

Topics: Costs, Variable cost, Profit Pages: 8 (2273 words) Published: October 3, 2009
Orion Controls Case

Executive Summary

Faced with the challenge of continuing to remain the leader in industrial valve systems, Orion Controls is required to decide whether or not to carry out product improvement redesigns. A successful redesign will secure the company an initial level of sales of 50 or 90 units to two new customers followed by the benefits of enjoying an innovator’s reputation.

An expected profit of $262,900 resulting from a product redesign given the information available with Orion and current commitments, the company is advised to carry out the redesign and sell to Avion Chemicals and Kemikal. Orion can make a profit of up to $655,000 if successful in achieving dramatic changes in its existing model SV44A-10 given successful software upgrade adopting the short-cut approach. With hitches through the software upgrade and product redesign, Orion might achieve lower profits or even incur losses, the worst scenario being a loss to the tune of $440,000 should the software update as well as product redesign both fail.

There is a 72% chance that Orion will make a profit; however, a 28% chance it will incur losses. The benefits clearly outweigh the losses, making this a favorable project for the company. Another advantage is that the company might be able to recover all of its redesign expenses thereby making upcoming production and sales more profitable in the future. The premium of being the innovating company is high. Companies must invest in Research & Development. Orion is a $600 million company and a R&D cost of $440,000 (the maximum cost to produce the valve) is a relatively minor cost. Body

This report presents profitability possibilities, risks and detailed analyses to assist Orion Controls to decide whether or not it should invest in improving its existing smart valve systems SV44A-10. Orion has contracted with Avion to redesign its current valve system whereby Avion will purchase 50 units of the redesigned valve provided completion within nine months. Kemikal has expressed an interest in purchasing the newly designed valve. Neither company is interested in purchasing the existing design.

• Key Decision Tree Results:

o If Orion successfully engineers dramatic improvements in the SV44A-10 valve, the company will realize a profit. Avion proposed purchasing 50 units and paying a 100% premium for a dramatically improved valve at a price of $20,000 per unit; $10,000 per valve plus a $10,000 premium. There is also a 60% probability of Kemikal purchasing an additional 40 units of the dramatically improved valve which will result in profits of $655,000. However, if the valve is only modestly improved, Avion will purchase 50 valves at price of $12,000; $10,000 per valve plus a 20% premium of $2,000. There is only a 30% chance Kemikal will purchase modestly improved valves. With only modest improvements to the valve, the redesign project will not be profitable to Orion.

o The software upgrade should be a major concern for Orion. If a short-cut approach is successful, the software development costs will be $120,000. However, if the short-cut approach fails, Orion will face an additional fixed cost of $240,000 for software development. In addition, the software development will take eight months to develop; which will put the project at risk for completion within the nine months promised to Avion. Orion will be profitable with dramatic improvements of the design. Both Avion and Kemikal have agreed to pay a 100% premium for dramatic improvements. However, if only modest improvements can be accomplished, Avion agreed to pay a 20% premium. At a selling price of $12,000 per unit, Orion will lose money on all of these sales since fixed costs are very high.

In view of the analyses performed, it is profitable for Orion to carry out its product improvement and redesign. This redesign is expected to generate a profit of $262,900 for the company given the...
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